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In UK, Weaker industrial production in January (-0.4% m/m) Industrial production weakened by 0.4% m/m in January. In particular, manufacturing production fell by a sharp 0.9% m/m. Activity in this sector was undoubtedly disrupted more severely by extremely bad weather conditions (snowstorms) than suggested by resilient surveys. Keeping tabs on the deficit cutting efforts of the government and the potential timing of the general election, Prime Minister Gordon Brown announced the annual budget would be released in two weeks. The policy official warned that the economy was still in the early stages of recovery; and the nation’s fragility would require loose monetary policy and keeping to the four-year deficit cutting program. As for data, factory activity fell for the first time in five months, confirming fears that the return to growth would be a bumpy one. The underlying trend in industrial activity remains upward oriented. Production is up by 1.0% on a 3m/3m basis and recent manufacturing surveys – such as the CIPS or the PMI – have continued to point to favourable prospects in the short term. While the global recovery has been broadly on track so far, it is too soon to break open the champagne. The next six months will prove critical for the global economy as the baton in the Western economies has to be delivered from massive stimulus and inventory correction to job growth and sustained recovery in final demand.

In Italy, Industrial production rose markedly in January (2.6% m/m). After falling by 0.2% m/m in December, industrial production rebounded in January. According to ISTAT’s estimate, industrial output rose by a solid +2.6% m/m. undoubtedly, production in the manufacturing sector is rebounding. The six-month rate of change, a good gauge of industrial output momentum, is increasing. Survey data signal that output could have continued to increase in February. However, they also suggest that the pace of increase could have moderated. There is still a long road to recovery. The level of industrial output is well below the level prevailing before the eruption of financial distress. In France, Manufacturing output resumed upward trend in January (+0.8% m/m). Industrial output increased markedly in January (+1.6% m/m), after a small drop in December (-0.2% m/m). In the manufacturing sector, output also resumed upward trend, but the increase was much more moderate. Output was up by 0.8% m/m in January, thus offsetting nearly the whole loss recorded in the previous month (-0.9% m/m). The recovery in the manufacturing sector is set to continue in the coming quarters, albeit at a moderate pace. In January, manufacturing output was 5.7% above its trough in April 2009, but still almost 15% below the level reached before the industrial recession started (February 2008). Euroland disappointed in late 2009. GDP only grew 0.5% annualised in Q4. In particular Germany posted a negative surprise with GDP stagnating in late 2009. However, factory orders for January suggest that activity has picked up again in early 2010. This is also signalled by continued increases in the German ifo expectations index and PMI new orders which tend to give good signals on Euroland growth. In Euroland, the jitters around fiscal sustainability have postponed the ECB’s exit and Danske do not foresee the first hike until early 2011. Worries about Greek public finances become a more general concern about global sustainability of public deficits, but remain mostly focused on some Euro area countries and the UK. As a consequence, public financing cost increases, with many countries’ long-term budget policies starting to lose credibility. Some countries are downgraded. Concerns partly spill over to the US, which also faces more expensive sovereign funding. This renewed round of scepticism is a toxic cocktail for the fragile recovery that is materialising in the Euro area. The loss of credibility in the financial market forces policymakers to front-load tightening of public budgets, which is not optimal at the current stage of the business cycle. The fiscal tightening derails the recovery in Euroland, but also takes air out of US growth. Macro data continues to disappoint and Euroland faces high unemployment and subpar growth for a prolonged period – this time anchored in the structural problems caused by the European welfare state model. Dismal growth and fiscal tightening leaves very limited – if any – room for central banks to normalise monetary policy. Both the ECB and the Fed leave rates on hold through 2011 and withdraw liquidity only very gradually from the system. At some point, further quantitative easing is considered likely. With fiscal credibility problems adding to longer-term sovereign funding costs, yield curves steepen further in both Euroland and the US. In this scenario, concerns about the euro as a single currency intensify and the currency weakens further. On the other hand, Asian currencies appreciate as the region remains the global power house and monetary tightening continues and macroeconomic balances are healthy. In recent months we have seen several indications of lacklustre growth in Euroland and the news that GDP hardly grew in the last quarter of 2009 was pretty terrifying. If Euroland slides back into a double dip at the current juncture not much can be done. The gas pedal is already at full speed with the loosest monetary and fiscal policy ever. Fortunately most forward looking indicators give more upbeat signals. Exports are likely to be a key driver of growth in the coming quarters. Danske expect the economic recovery to continue, but due to a weak Q4 reading, Danske lowered our GDP projection for 2010 to 1.8% y/y. This is still above the consensus projection of 1.3% y/y. The fiscal chaos in Greece has been a key driver of the financial markets. Greece is now moving in the right direction as it has put rather ambitious austerity plans forward. ECB will continue with its exit strategy for non-standard measures. Danske expect a first interest rate hike in Q1 2011. Inflation will remain low in both 2010 and 2011.

US trade shortfall has been trending up in recent months – partly reflecting higher imports of crude oil. But as January’s FOMC minutes noted, the bigger picture favours net trade as a driver of US economic activity as key export markets revive. Indeed, the annual rate of change in US industrial production is now in positive territory for the first since March 2008. Elsewhere in terms of US data, we expect initial jobless claims to have fallen by around 20k in the week ending 6 March, broadly in line with the consensus forecast. The global recovery has continued broadly on track over the past three to six months. The US delivered a positive surprise in Q4 with growth close to 6% q/q annualised and growth in H2 09 has been in line with Danske’s expectations of 4.0-4.5% growth. Although the inventory cycle has provided some of the boost, it is encouraging that final demand has also picked up. In particular, investment in equipment and software grew strongly in Q4. We are now at the stage in the global economy where the fuel will taper off. It will therefore become increasingly obvious whether the global economy will manage to escape the gravity pull. The task is quite big since gravity is particularly strong this time due to the damage to the banking sector, high debt levels and massive wealth losses that are still lingering. Another reason why this phase is so critical is that we do not have much fuel left to use should it be needed again if the economy falters. Fiscal policy is more or less maxed out everywhere and there is also a limit as to how much more can be done through monetary policy – although more money can be printed. Indeed, 2010 is likely to prove to be a ‘make or break’ year. Fortunately, we see increasing signs that labour markets are improving globally which is the main precondition for a real lift-off. Unemployment rates have either fallen or stabilised in most Western economies and in Asia unemployment is already on a clear downward path. A short-term model for US non-farm payrolls suggests decent job gains over the next three to six months and our expectation is monthly job growth of around 200-250k over this horizon. All evidence suggests that once unemployment starts to go down it normally continues to decline for a considerable period: it becomes a sustainable recovery that feeds on itself. The process works through a variety of channels. First, employment gains increase disposable income growth for households and support consumption growth. Second, the decline in unemployment gives rise to higher job security and therefore reduces the need for precautionary savings. Third, the improvement in consumer demand triggers companies to scale up investment plans as the uncertainty over demand fades and focus shifts from crisis management to strategic management. Finally, as this is a process taking place in most of the world economy, it will improve external demand as well and give a lift to export growth and world trade will benefit. It is still too early to conclude that we have entered this positive spiral. The global economy is still fragile during this transition phase and in the past we have seen double-dip recoveries because new shocks have hit the economy during this critical period when sentiment is vulnerable. It is therefore important that we don’t get hit by new shocks over the next 6-12 months. By definition, shocks are difficult to forecast but there are a number of candidates to watch out for: an acceleration of the public debt crisis, renewed significant bank losses damaging market confidence, a spike in oil prices or a rise in protectionism. The global economy currently has maximum fuel from stimulus and the inventory cycle and this effect is about to taper off. We already see signs of the growth peak in some leading indicators. For example, global PMI new orders fell in January and momentum in OECD’s leading indicator has been on a downward path for some months now. The transition from acceleration to cruising speed is likely to create more (realised) volatility in financial markets in 2010. Indeed, we have already witnessed this in early 2010 where equity markets saw the biggest correction since early 2009 when equity markets bottomed. Markets will be caught between (a) slowing speed which tends to spur fears that growth will slow too much and cause a double-dip scenario, and (b) rising signs of sustainability from improving labour markets which should work as comfort that a double-dip scenario will not materialise. At the same time, expectations for earnings growth are quite high, leaving scope for disappointments. Although the global economy is recovering, central banks are likely to move slowly in their exit strategies. Inflation is expected to stay at moderate levels in the Western economies as wage pressures are low and pricing power poor. In the US, unemployment has risen to very high levels and there will be plenty of slack in the economy for a long time. Non-standard measures will be scaled out gradually during 2010 but Danske don’t expect the Fed to hike before late 2010. Recent indicators on the US labour market have been mixed, leading to fears about a repeat of the 1991 and 2002 jobless recoveries. However, in many ways, the recession we have just been through corresponds more to the deep recessions in the 1970s and 1980s than the shallow downturns in 2001 and 1990-91. Jobs have been cut hard during the downturn and businesses are leaner than following the two previous recessions. With production picking up rapidly in Q4 09, the need for increased labour input is building. Lately this has been reflected in a jump in hours worked and temporary help service. In this alternative scenario employment growth recovers at an express pace, reaching above 350,000 persons per month in H1 10. The leap in job growth should foster positive dynamics in the rest of the economy with domestic demand recovering fast as private consumption and investments growth get a boost. A strong recovery in US domestic demand will have positive spill-over effects on Euroland and Asian exports. Euroland exports will be further supported by a strengthening in the dollar against the euro as relative growth and interest rates lend support to the currency.

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